Blocher Fifth Edition Stout Retool, Refocus, Reassess ......Cost Management A Strategic Emphasis...

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CokinsRetool, Refocus, Reassess – today’s economic climate calls for management accoun-tants who not only provide critical financial information, but also actively participate in decision making and implementation at the highest levels in organizations across the global marketplace.

Cost A , 5th edition by Blocher, Stout, and Cokins, provides students with the firm knowledge and understanding of cost accounting in a way that will apply to a real-world working environment.

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Cost , 5th edition, uses a strategic emp-hasis to make the connections between concepts and procedures clear to students. Throughout the text, the 5 Steps of Strategic Decision Making demonstrate how a business decision starts and ends with consideration of the organization’s strategy. By walking students care-fully through the decision-making process, the 5 Steps help students analyze the strategic factors that play into the management team’s ultimate conclusions.

Additional key features of Cost , 5th edition address today’s students’ need for currency, relevancy, and context:

and economic crisis content and end-of-chapter exercises and activities.

Real-World Focus boxes throughout the text take real companies and demonstrate strategy in action.

Excel Tutorials available for each chapter provide beginner, intermediate, and advanced topics for students to hone their Excel skills.

New to Cost Management, 5th edition

Practice4Performance (P4P), an online assignment and exam manager. P4P is developed specifically for Cost , 5th edition, by Professor Paul Goldwater at the University of Central Florida, and won the 2008 American Accounting Association Jim Bulloch Award for Innovation in Management Ac-counting Education.

P4P is a complete solution for management of assign-ments and exams, as well as an online opportunity for students to practice on their own beyond their cost accounting assignments.

Library of over 3,000 questions updated with new data on each student session

Administers student practice sessions, assignments, and exams

Automatic grading

Integrated communication features

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Cost Management

A Strategic Emphasis

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Cost Management

A Strategic Emphasis Fifth Edition

Edward J. Blocher University of North Carolina at Chapel Hill Kenan-Flagler Business School

David E. Stout Youngstown State University Williamson College of Business Administration

Gary Cokins Strategist, Performance Management Solutions SAS/Worldwide Strategy

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COST MANAGEMENT: A STRATEGIC EMPHASIS

Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020. Copyright © 2010, 2008, 2005, 2002, 1999 by The McGraw-Hill Companies, Inc. All rights reserved. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.

Some ancillaries, including electronic and print components, may not be available to customers outside the United States.

This book is printed on acid-free paper.

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ISBN 978-0-07-352694-2 MHID 0-07-352694-0

Vice president and editor-in-chief: Brent Gordon Editorial director: Stewart Mattson Executive editor: Richard T. Hercher, Jr. Editorial coordinator: Rebecca Mann Marketing manager: Kathleen Klehr Senior project manager: Bruce Gin Production supervisor: Michael McCormick Designer: Matt Diamond Senior media project manager: Greg Bates Cover design: Jenny El-Shamy Interior design: Matt Diamond Typeface: 10/12 Times Roman Compositor: Laserwords Private Limited Printer: R. R. Donnelley

Library of Congress Cataloging-in-Publication Data

Blocher, Edward. Cost management : a strategic emphasis / Edward J. Blocher, David E. Stout, Gary Cokins.—5th ed. p. cm. Includes index. ISBN-13: 978-0-07-352694-2 (alk. paper) ISBN-10: 0-07-352694-0 (alk. paper) 1. Cost accounting. 2. Managerial accounting. I. Stout, David Edward. II. Cokins, Gary. III. Title. HF5686.C8B559 2010 658.15 ' 52—dc22 2009015756

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We dedicate this edition . . .

To my wife, Sandy, and our sons, Joseph and David Ed Blocher

To my wife, Anne, and our sons, David and Kevin David E. Stout

To my wife, Pam Tower, and my mentor, Robert A. Bonsack—a true craftsman in the field of cost management

Gary Cokins

Special Dedication: In recognition of the significant influence he has had on management accounting, and in particular on our thinking about strategic cost management, we dedicate this edition to the memory of Professor John K. Shank .

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Edward J. Blocher is professor of accounting at the Kenan-Flagler Business School at the University of North Carolina at Chapel Hill. His undergraduate degree (economics) is from Rice University, his MBA from Tulane University, and his Ph.D. from the University of Texas at Austin. Professor Blocher presents regularly on strategic cost management at the national meetings of both the American Accounting Association (AAA) and the Institute of Management Accountants (IMA).

While he is involved in a number of accounting organizations, Professor Blocher has been most continually active in the IMA, where he is now a trustee of the Foundation for Applied Research (FAR). He is a certified management accountant (CMA), has taught review courses for the CMA exam, and has served on the IMA’s national education committee. Professor Blocher is also the author or co-author of several articles in management accounting and in other areas of accounting and has served as associate editor and reviewer for a number of accounting journals. Recently he published an article in Issues in Accounting Education (February 2009) on the topic of teaching strategic cost management.

Putting research and teaching into practice is important to Professor Blocher, who has worked closely with other firms and organizations in developing products, publications, and teaching materials. He was a member of the task force for the IMA that developed a new definition of management accounting in 2008. He currently serves as the chair of academic research propos-als for the IMA’s FAR program. Also, he has provided expert testimony and has consulted with a number of organizations, including Blue Cross and Blue Shield of North Carolina, the American Institute of CPAs, Grant Thornton, and the State of North Carolina, among others.

David E. Stout is the John S. and Doris M. Andrews Professor of Accounting, Williamson College of Business Administration, Youngstown State University. Previously, he held the position of the John M. Cooney Professor of Accounting, School of Business, Villanova University. David earned his Ph.D. in accounting (1982) from the Katz Graduate School of Business, University of Pittsburgh and teaches in the cost/managerial accounting area. He served previously as editor of Issues in Accounting Education and serves currently as senior associate editor of the Journal of Accounting Education and as a member of the editorial board of each of the following journals: Issues in Accounting Education; Journal of Interna-tional Accounting, Auditing & Taxation; China Finance and Accounting Review; International Journal of Management Education; IMA Educational Case Journal; and, Management Ac-counting Quarterly/Strategic Finance. In addition, he serves as a member of the editorial advi-sory board of Accounting Education: An International Journal. Professor Stout has published over 75 articles in numerous professional and academic journals including Advances in Ac-counting Education, Issues in Accounting Education, the Journal of Accounting Education, The Accounting Educators’ Journal, Advances in International Accounting, Behavioral Research in Accounting (BRIA), The CPA Journal, Educational and Psychological Measurement, Manage-ment Accounting, Management Accounting Quarterly, Financial Practice and Education, Stra-tegic Finance, and Advances in Accounting. David is past president of the Teaching, Learning & Curriculum (TLC) Section of the AAA, past president of the Academy of Business Education (ABE), and past president of the Ohio Region, American Accounting Association (AAA). In 2007, he was the recipient of the R. Lee Brummet Award for Distinguished Accounting Educa-tors, Institute of Management Accountants (IMA), and the Ohio Outstanding Accounting Edu-cator Award, which is cosponsored by the Ohio Society of CPAs and the AAA’s Ohio Region. In 2008, David received the Distinguished Achievement in Accounting Education Award from the AICPA, and the Distinguished Service Award for Educators given by the IMA. Also in 2008, David was inducted into the Hall of Honor, TLC Section of the AAA and was selected by Ohio Magazine as one of Ohio’s Outstanding College and University Teachers.

Meet the Authors

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Meet the Authors vii

Gary Cokins is a global product marketing manager involved with performance-management solutions with SAS, a leading provider of business analytics software. Gary is an internationally recognized expert, speaker, and author in advanced cost manage-ment and performance-improvement systems. He received a BS degree in industrial engineering/operations research (with honors) from Cornell University in 1971 and an MBA from Northwestern University’s Kellogg School of Management in 1974. Gary began his ca-reer as a strategic planner with FMC Corporation and then served as a financial controller and operations manager. In 1981 he began his management consulting career with Deloitte Consulting and continued with KPMG Peat Marwick. He then headed the National Cost Man-agement Consulting Services for Electronic Data Systems (EDS). Gary was the lead author of the acclaimed A Manager’s Primer on ABC Costing, published by the IMA. He also has two successful books in Activity-Based Costing and Performance Management. Gary partici-pates and serves on professional society committees including: The Consortium for Advanced Management–International (CAM-I), the Supply Chain Council, the IMA, and the Interna-tional Federation of Accountants (IFAC). He is also a member of Journal of Cost Management Editorial Advisory Board.

The Author Team: Selected to provide a leading book in cost management based on leadership in teaching experience, commitment to learning, and up-to-date knowledge of real-world management accounting practices.

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Blocher/Stout/Cokins:

Welcome to Students: We have written this book to help you understand the role of cost management in helping an organization succeed. Unlike many books that aim to teach you about accounting, we aim to show you how an impor-tant area of accounting, cost management, is used by managers to help organizations achieve their goals.

An important aspect of cost management in our text is the strategic focus. By strategy we mean the long-term plan the organization has developed to compete successfully. Most organizations strive to achieve a competitive edge through the execution of a specific strategy. For some firms it is low cost, and for others it might be high quality, customer service, or some unique feature or attribute of its product or service. We know in these competitive times that an organization does not succeed by being ordinary. In contrast, it develops a strategy that will set it apart from competitors and ensure its attractiveness to customers and other stakeholders into the future. The role of cost management is to help management of the organization attain and maintain success through strategy implementation. Thus, for every major topic covered in our text there is a larger issue, which is: “How does this orga-nization compete? What type of cost-management information does it need?” We do not cover a cost-management method simply to become proficient at it. We want you to know why, when, and how the technique is used to help the organization succeed.

A strategic understanding of cost management is so important that many senior financial manag-ers are coming back to school to learn more about strategy, competitive analysis, and new cost-management techniques. Knowing how to do the accounting alone, no matter how well you do it, is by itself no longer sufficient. Cost management with a strategic emphasis is one way to enhance your career and to add value to your employer, whatever type of organization it might be.

Real-World Focus Cost Management, 5e, explains how accounting systems can add value to the organization. The Real-World Focus boxes throughout the text take real organizations and demonstrate strategy in action and the role that cost man-agement plays in supporting the organization’s strategy.

We often associate the differentiation strategy with firms that have an outstanding new innovation or that excel in customer service, qual-ity, or product features, but sometimes a differentiation approach can help a firm that competes in an industry that is characterized by cost leaders. One example is the furniture maker, Craftique, in Mebane, North Carolina. Like many furniture firms, 57-year-old Craftique has been struggling to compete with low-cost suppliers from China and other global competitors. In a new direction, it now succeeds by spe-cializing only in high-end furniture with lots of fabric choices, colors, and allowing the customer to participate in the product design over the firm’s Web site. Other furniture manufacturers that follow the cost leadership model strive to compete by outsourcing production to low-cost suppliers and/or investing in automation to reduce operat-ing costs.

Magnatag Visible Systems in Macedon, New York, competes in the commodity market for erasable whiteboards used in class-rooms and training centers by customizing its product for church groups, hospitals, and other organizations—adding graphics and

unique grids needed by these customers. Lenovo, competing in the low-cost notebook market, pitches the durability of its product, sometimes bouncing it on tabletops at sales meetings with corporate clients to stress its strength and durability. John Deere and Bobcat, makers of farming and construction equipment, rely on innovation, close physical location to customers, and close attention to customer expectations to succeed in a very competitive global industry. Some supermarkets that face competition from Wal-Mart’s supercenters have chosen to compete and succeed by focusing on customer serv-ice, a pleasant shopping environment, and by carrying hard-to-find items. Sometimes a little differentiation can make the difference.

Source: “Fine Furniture a Leg to Stand On,” The Durham Herald. February 17, 2004, p. B1; Gwendolyn Bounds, “Taking the Common out of Commodity,” TheWall Street Journal, June 26, 2007, p. B1; Jane Spencer, “Can Durability Trump Price in Laptop War?” The Wall Street Journal, May 17, 2007, p. B1; Timothy Aeppel, “Still Built on the Home Front,” The Wall Street Journal, October 24, 2006, p. B1; Michael Arndt, “ Deere’s Revolution on Wheels,” The Wall Street Journal, July 2, 2007, p. B1; Gary McWilliams, “Not Copying Wal-Mart Pays Off for Grocers,” The Wall Street Journal, June 6, 2007, p. B1.

REAL-WORLD FOCUS Highly Cost-Competitive Industries: Surviving through Differentiation

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To augment this coverage, the Blocher team encourages students to further explore real-world companies through Cost Management in Action boxes that appear throughout the text. This feature poses important questions that make students think critically about the relationship between cost management and management strategy. At the end of each chapter, the authors then supply their comments for the Cost Management in Action boxes.

Cost Management in Action A Case in Competitive Strategy: Wal-Mart and Target

Wal-Mart and Target are two of the most successful retailers in the United States. Wal-Mart bears the slogan, “Save Money, Live Bet-ter,” while Target stores say “Expect More, Pay Less.” If you have shopped at either of these stores you will likely have formed an opin-ion about the stores and how they compete.

Required1. Based on your experience, explain what you think are the com-

petitive strategies of these retailers. Are they key competi-tors, targeting the same customers? Do you think each firm has adopted the most effective strategy? Why or why not?

2. Recently Wal-Mart has begun to advertise in the high-fashion magazine Vogue. How does this fit the firm’s strategy, or does it?

3. While customer’s are pleased with Wal-Mart’s low prices, there is ongoing controversy about the firm’s negative effect on other retailers where Wal-Marts are located. For example, the closing of 30 supermarkets in Oklahoma City in recent years has been attributed to Wal-Mart’s arrival. What are your thoughts on the controversy? Are the ethical principles and standards of the man-agement accountant relevant in this context?

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Problem Material The Blocher team has taken great care to develop assignment material that effectively reinforces concepts, procedures, and strategic issues presented in each chapter. In addition, each chapter has one or more end-of-chapter assignments that focus on an international context or a service (i.e., nonmanufacturing) setting. Other end-of-chapter assignments require the use of Excel or the consideration of ethical issues to the topic at hand. All such assignments are marked appropriately for easy identification, as follows:

Strategy International Service Ethics Excel

Key Text Features that Integrate the Strategy Emphasis

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instructor, the other for students. Each workbook provides for the instructor the solution to every exercise and problem in the chap-ter, each in its own worksheet in the workbook. Each solution has three components: background information, data, and solution/model-building. The Excel solutions provide the basis for the instructor to both guide students through the use of Excel in solving problems, and a useful tool for generating new problems.

The Excel Solutions Manual also has a student version that differs from the instructor’s version in only one respect: worked-out solutions are available for only half of end-of-chapter exercises and problems. The remaining problems (without solutions) can be used for Excel assignments. In other respects the student version of the manual is identical to the instructor version. Because all pertinent information for each exercise and problem, including background information and data, is included in each worksheet, the Excel Solutions Manual is very easy to use.

Cases and Reading Manual The supplemental Cases and Readings Manual, available in electronic form, challenges students to think about and use cost-management information in a real-world setting. The longer articles provide a basis for more comprehen-sive and in-depth discussions about the role of cost management in helping an organization successfully execute its strategy. We have found the Cases and Readings Manual to be particularly useful for upper-level undergraduate courses and for MBA course offerings.

Tegrity Campus: Lectures 24/7 Tegrity Campus is a service that makes class time available 24/7 by automatically capturing every lecture in a searchable format for students to review when they study and complete assignments. With a simple one-click

start-and-stop process, you capture all computer screens and corresponding audio. Students can replay any part of any class with easy-to-use browser-based viewing on a PC or Mac.

Educators know that the more students can see, hear, and experience class resources, the better they learn. In fact, studies prove it. With Tegrity Campus, students quickly recall key moments by using Tegrity Campus’s unique search feature. This search helps stu-dents efficiently find what they need, when they need it, across an entire semester of class recordings. Help turn all your students’ study time into learning moments immediately supported by your lecture.

To learn more about Tegrity watch a 2-minute Flash demo at http://tegritycampus.mhhe.com.

Assurance of Learning Ready Many educational institutions today are focused on the notion of assurance of learning, an important element of some accreditation standards. Cost Management is designed specifically to help support your assurance of learning initiatives with a simple, yet powerful solution.

Test bank questions for Cost Management map to a specific chapter learning outcome/objective listed in the text. You can use our test bank software, EZ Test and EZ Test Online to easily query for learning outcomes/objectives that directly relate to the learning objectives for your course. You can then use the reporting features of EZ Test to aggregate student results in similar fashion, making the collection and presentation of data simple and easy.

AACSB Statement The McGraw-Hill Companies is a proud corporate member of AACSB International. Understanding the importance and value of AACSB accreditation, Cost Management, 5e recognizes the guidelines detailed in the AACSB standards by connecting selected questions in the test bank to the six general knowledge and skill areas in the AACSB standards.

The statements contained in Cost Management, 5e are provided only as a guide for the users of this textbook. The AACSB leaves content coverage and assessment within the purview of individual schools, the mission of the school, and the faculty.

Text Illustrations Clear and concise exhibits help illustrate basic and complicated topics throughout the book.

Excel Solutions Manual Introduced for the fourth edition, the Excel Solutions Manual is revised and updated. This supple-ment consists of an Excel workbook for each chapter and comes in two versions: one for the

Helping Students Succeed Using Cost Management, 5e

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EXHIBIT 11.21 Windbreakers Production and Sales Possibilities Two Production Constraints—Sewing Machine and Inspection

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What’s NEW about the 5th edition of

New Framework to Integrate Strategy: The Five Steps of Strategic Decision Making

The first edition of Cost Management introduced a five-step framework for decision making with a strategic emphasis. The

framework shows that each decision starts and ends with a consideration of the organization’s strategy. To extend and inte-

grate the strategic emphasis, the fifth edition has included the five-step framework throughout the text. In all but a few chap-

ters there is a short section that uses the five-step framework to show how a consideration of the organization’s strategy plays

a key role in making the decision that will address the business-related problems presented in that chapter.

The Current Economic Recession Increases the Importance of Reviewing and Executing Strategy

The current economic recession is addressed in the text, both in the chapters and in the end-of-chapter exercises and problems.

The recession requires firms to place an even greater emphasis on executing their strategy. Moreover, the economic difficulties

may require a firm to review and modify its strategy to compete more effectively in the changed economic conditions.

Online Supplement for Assignments, Exams, and More. . .

A new learning supplement, Practice4Performance (P4P), is available for use with the fifth edition. P4P was developed

by Professor Paul Goldwater at the University of Central Florida. P4P is the 2008 winner of the American Accounting

Association’s Jim Bulloch Award for Innovations in Management Accounting Education. P4P does the following for the

instructor:

Provides a library of over 3,000 questions that are updated with new data each time the system is accessed by the student; detailed solutions are included for each question.

Simulates scenarios– P4P has the ability to create randomized, multistep analytical problems that vary significantly with each iteration, saving instructors valuable time in creating their own materials.

Provides partial credit on multiple-choice questions as a built-in option that decreases the points awarded per question as the number of attempts increases.

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Has live tracking of all statistics related to student practice sessions, homework, quizzes, and exams.

Provides flexibility in how to structure and schedule quizzes and exams—the number of questions, difficulty level of questions, types of questions (e.g., qualitative- or calculation-based), and learning objectives addressed are all within the control of the instructor.

Administers assignments, grading, and interaction through P4P-integrated communication features such as online document posting, class/individual announcements, and message boards.

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Excel Tutorials

Free to adopters of the fifth edition is a set of Excel tutorials, one for each chapter. This new resource provides a context-

based means for students to hone their Excel skills. In many cases, the Excel tutorial is linked to the demonstration problem

included at the end of the chapter. The tutorials cover a wide variety of Excel topics, from elementary to the intermediate

level, and some at the advanced level. The tutorials are an easy way for students to learn more about Excel without having to

ask the instructor.

New Chapter Organization and Parts Introductions

The new edition has reorganized the parts and sequence of chapters to follow the sequence used by many of our

adopters. Thus, the process-costing and cost-allocation chapters were moved up, and capital budgeting is now included

as a chapter in the section on planning and decision making. These two changes permit a more streamlined presentation.

There are now four major parts to the text: Part One, introduction to strategy, cost management, and cost systems;

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Cost Management?

Part Two, planning and decision making; Part Three, operational-level control; and Part Four, management-level control.

A new feature of the text is the inclusion of an introduction to each of the four parts to explain the learning objectives

of the chapters in that part. Briefly, the objective of Part One is to introduce foundational concepts, including strat-

egy, strategy implementation, and product-costing systems. The coverage of cost systems begins with job costing and

is followed by ABC, process costing, and joint product costing/cost allocation. Part Two, planning and decision mak-

ing, begins with cost estimation, since planning and decision making are guided by knowledge of cost drivers and cost

behavior. Covered in Part Two is short-term profit-planning (CVP), budgeting, decision making, capital budgeting,

target costing, the theory of constraints, and pricing. Parts Three and Four study performance measurement: Part Three

looks at this issue from the perspective of those who manage operations on a day-to-day basis, while Part Four

examines performance evaluation at a higher level: business-unit managers who have responsibility for divisions,

product lines, or manufacturing plants, and whose units are evaluated as cost centers, profit centers, or investment

centers.

Integration of Important Topics throughout the Text

Key topic areas for the course are integrated across the chapters. As noted above, strategy is integrated throughout the text.

In addition, accounting for “lean” is included in four chapters as it relates to the subject matter of that chapter. Similarly,

time-driven activity-based costing (TDABC) is covered in the ABC chapter and also in the chapter on budgeting. ABC

appears in most of the chapters in Part Two, as it has a key role in planning and decision making. Nonfinancial performance

measures and the balanced scorecard (BSC) are introduced in Part One and then covered as part of operational and manage-

ment control chapters included in Parts Three and Four. Resource consumption accounting (RCA) is covered both in Chapter

5 and again in Chapter 15. The topic of capacity resource planning is covered in Chapters 10 and 15. These are just exam-

ples of the efforts the authors have made to integrate key topics throughout the text.

Important Changes in Each Chapter of the Fifth Edition

Part One: Introduction to Strategy, Cost Management, and Cost Systems

Chapter 1: Cost Management and Strategy

• Inclusion of the IMA’s new (2008) definition of management accounting and linkage of the definition to the objectives of the text. The new definition stresses the role cost management has in helping an organization develop and implement its strategy.

• Complete reorganization to show more clearly the elements of the contemporary business environment and the management accountant’s response to the new business environment; new terms added include lean accounting, business intelligence, the strategy map, enterprise sustainability, and enterprise risk management.

• Enhanced coverage of the role of cost management in the global economy and in the current economic recession.

• New Real-World Focus (RWF) examples throughout the chapter, including surveys of current practice.

Chapter 2: Implementing Strategy: The Value Chain, the Balanced Scorecard, and the Strategy Map

• New Real-World Focus (RWF) examples, including surveys of current practice.

• Expanded coverage of the strategy map with an entirely new illustration and including new exercise material.

• Increased coverage of sustainability.

• Enhanced material on implementation issues associated with the balanced scorecard (BSC).

• New exercises and problems with an emphasis on strategy and the value chain.

Chapter 3: Basic Cost Management Concepts

• New Real-World Focus (RWF) examples.

• New exercises and problems.

• Shortened, more clarified presentation in the chapter.

Chapter 4: Job Costing • New Real-World Focus (RWF)

examples.

• Replacement of old ledger-based exhibits with new exhibits based on job-costing software.

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• Shortened, more clarified presentation of the chapter.

• New exercises and problems with a focus on service industries.

Chapter 5: Activity-Based Costing (ABC) and Customer Profitability Analysis

• New coverage of resource consumption accounting (RCA) and lean accounting.

• New Real-World Focus (RWF) examples, including surveys of current practice.

• Expanded coverage of time-driven ABC (TDABC).

• Expanded coverage of customer lifetime value, introduction of the concept of customer equity, and discussion of strategy implementation for customer profitability analysis.

• New exercises and problems focusing on strategy, the cost of capacity, resource consumption cost drivers, and ethics.

Chapter 6: Process Costing • Revised coverage of backflush

costing with a new illustration and associated end-of-chapter assignment material.

• New problem material with a focus on sustainability.

Chapter 7: Cost Allocation: Departments, Joint Products, and By-Products

• New Real-World Focus (RWF) examples.

• New assignment material with a focus on service companies.

• Revision to clarify the relationship between departmental cost allocation and the costing methods used elsewhere in the text.

• Complete rewrite of Exhibits 7-10, 7-11, and 7-12 to clarify these exhibits.

Part Two: Planning and Decision Making

Chapter 8: Cost Estimation • Several new Real-World Focus

(RWF) boxes featuring examples from Freakonomics (Steven D. Levitt and Stephen J. Dubner) and Super Crunchers (Ian Ayres).

• New self-study problem and exercise on nonlinear regression.

• Improved exhibits to illustrate the use of Excel for regression analysis.

• New exercises and problems with a focus on research using the Internet.

Chapter 9: Profit Planning: Cost-Volume-Profit Analysis

• New Real-World Focus (RWF) examples, including one in a global context and another that focuses on the analysis of automobile fuel efficiency.

• New section on the use of value streams and lean accounting for short-term profit-planning.

• Revision and extension of the section on ABC-based CVP analysis.

• New problems and examples with an emphasis on strategy and service organizations.

Chapter 10: Strategy and the Master Budget

• New discussion of “what-if ”/sensitivity analysis and related end-of-chapter Excel-based exercises and problems.

• Use of the statement of cash flow format for preparation of cash budgets.

• Extension of activity-based budgeting (ABB) to time-driven activity-based budgeting (TDABC) and related discussion of capacity resource-planning issues.

• Expanded discussion of incentive issues regarding budgeting systems, including the “Beyond Budgeting”

controversy, alternative incentive-compensation schemes, and the use of rolling financial forecasts.

• Increased number of service-based and strategy-related end-of-chapter exercises and problems.

Chapter 11: Decision Making with a Strategic Emphasis

• Updated Real-World Focus (RWF) examples.

• New section on the use of value stream management and lean accounting in decision making.

• New exercises and problems with a special focus on strategy.

Chapter 12: Strategy and the Analysis of Capital Investments

• Discussion of the modified internal rate of return (MIRR) evaluation criterion.

• For equipment-replacement type decisions, presentation of alternative formats for structuring the analysis: total cash flows vs. analysis of differential cash flows.

• Coverage of the topic of real options as a means of dealing with uncertainty in the analysis of capital budgeting projects.

• Inclusion of additional strategy-related end-of-chapter assignments.

• Addition of new Real-World Focus (RWF) items.

Chapter 13: Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints (TOC), and Strategic Pricing

• New coverage of analytical pricing methods, including illustrations.

• New and updated Real-World Focus (RWF) examples throughout the chapter.

• New exercises and problems with a focus on strategy and on service industries, including an example of a TOC application in a restaurant.

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Part Three: Operational-Level Control

Chapter 14: Operational Performance Measurement: Sales and Direct-Cost Variances, and the Role of Nonfinancial Performance Measures

• Reorientation of chapter contents to focus initially on the use of flexible budgets and standard costs for short-term financial control.

• Inclusion of additional strategy-related end-of-chapter assignments.

• New section, and related assignment material, regarding just-in-time (JIT) manufacturing.

• New section regarding the use of nonfinancial performance indicators and linkage to an organization’s balanced scorecard (BSC).

• Five new Real-World Focus (RWF) items.

Chapter 15: Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Planning

• Inclusion of Statement of Financial Standards No. 151: “Inventory Costs—An Amendment of ARB No. 43, Chapter 4” ( www.fasb.org/pdf/aop_FAS151.pdf ).

• New discussion regarding capacity resource planning and the role of ABC data for managing resource-capacity spending.

• New discussion regarding earnings-management opportunities (under absorption costing) based on choice of denominator volume level.

• New discussion regarding both variable and short-term fixed-cost components in batch-level support costs tracked by ABC systems.

• Five totally new end-of-chapter problems, including three covering strategy, one service-context

problem, and one ethics-related problem.

• Inclusion (Appendix) of the expected value of perfect information (EVPI) within the context of the variance-investigation decision under uncertainty.

Chapter 16: Operational Performance Measurement: Further Analysis of Productivity and Sales

• New Real-World Focus (RWF) examples, updated for recent survey data.

• New section on lean manufacturing with related exercise material.

• Greater emphasis on strategy, including a five-step example illustrating the role of market variances in strategy implementation.

• New end-of-chapter material with a focus on the current economic recession.

Chapter 17: The Management and Control of Quality

• Expanded discussion of “lean” as a strategy, as well as cost-system design issues associated with lean manufacturing.

• Inclusion of five new Real-World Focus (RWF) items.

• Seven totally new end-of-chapter exercises, plus two new research-based end-of-chapter problems.

• Inclusion of more strategy-related end-of-chapter assignments.

Part Four: Management-Level Control

Chapter 18: Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard (BSC)

• New and updated Real-World Focus (RWF) examples, including surveys from practice.

• New section covering accounting for lean, including a related end-of-chapter exercise.

• New problems with a focus on strategy, globalization, and ethics.

• Shortened, improved, and more focused coverage of the implementation of the balanced scorecard (BSC) for performance measurement.

Chapter 19: Strategic Performance Measurement: Investment Centers

• New discussion regarding strategic issues associated with the use of ROI as a financial-performance indicator.

• Expanded discussion of estimating EVA® NOPAT and EVA® Capital, using both the financing approach and the operating approach.

• Presentation and discussion of a general transfer pricing rule, including implementation issues associated with this rule.

• Ten totally new end-of-chapter exercises and problems, including assignments related to strategic considerations, service-sector applications, the use of Excel, and international operations.

• Two new Real-World Focus (RWF) items in the body of the chapter, one dealing with transfer-pricing issues, the other dealing with estimating human capital ROI.

Chapter 20: Management Compensation, Business Analysis, and Business Valuation

• New and updated Real-World Focus (RWF) examples, including updated surveys from practice and examples that include the effect of the current economic recession on compensation, business analysis, and business valuation.

• New problem material with a focus on strategy and value creation.

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http://www.fasb.org/pdf/aop_FAS151.pdfhttp://www.fasb.org/pdf/aop_FAS151.pdf

Rev. Confirming PagesRev. Confirming Pages

Supplements Instructor’s Resource CD-ROM (ISBN 007724351X): Contains all essen-tial course supplements such as the Instructor’s Resource Manual, Solutions Manual–Word

format (both student and instructor versions), Test Bank (Word format), EZ Test Bank,

PowerPoint® Presentations, and Excel Solutions Manual (both student and instructor

versions). All instructor supplements are prepared by the authors.

Online Learning Center (OLC): www.mhhe.com/blocher5e . The Instructor Edition of the Cost Management: A Strategic Emphasis, 5e OLC is password-protected and another convenient place for

instructors to access course supplements. Resources for professors include: the

Instructor and Student Solutions Manual (in both Word and Excel formats),

teaching notes for the casebook, links to professional resources, sample syllabi,

text updates, and the set of Excel tutorials.

Practice4Performance (P4P) (ISBN 0077997557 for book and P4P access card): A new learning supplement, Practice4Performance (P4P), is an online assignment and exam manager. It provides over 3,000 questions that are

updated with new data on each student session with the system. This is a great

system to use with large sections, and where the instructor wants to provide the students with

the incentive to improve their performance in the course by “practicing for performance.” The

system not only administers student practice sessions, assignments, and exams (including auto-

matic grading of all sessions, assignments and exams), but also provides student and instructor

interaction features such as online document posting, class/individual announcements, and

message boards. It is a complete solution for easy management of assignments and exams, and

a great incentive for students to try practice questions in addition to those assigned.

For Instructors...

For Students... Cases and Readings for use with Cost Management: A Strategic Emphasis, 5e: This manual contains cases and articles covering a variety of important topics. The case scenarios put students in situations that allow them

to think strategically and to apply concepts they’ve learned in the course. Key readings

have been chosen to give students more background into the evolution of strategic cost

management topics as well as to contemporary controversies in the field.

Online Learning Center (OLC): www.mhhe.com/blocher5e . The Student Edition of the Cost Management: A Strategic Emphasis, 5e OLC contains many tools

designed to help students study, including: the Cases and Readings Manual, check figures,

text updates, links to professional resources, chapter overviews, chapter objectives, multiple-

choice quizzes, Excel tutorials, Present Value tables, and PowerPoint® presentations.

SAS Software: SAS’s Activity-Based Costing (ABC) software is used worldwide for performance management functions and analysis. Cost Management incorporates SAS

Software in its ABC case material to prepare students for calculating ABC costs, creating

cost-driver assignments, and organizing cost information using real-world software. Visit the

Blocher OLC today to learn more!

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http://www.mhhe.com/http://www.mhhe.com/blocher5e

Confirming Pages

xv

Acknowledgments Our Sincerest Thanks . . . In writing this book, we were fortunate to have received extensive feedback from a number of accounting educators. We want to thank our colleagues for their careful and complete review of our work. The comments that we received were invaluable in helping us to shape the manu-script. We believe that this collaborative development process helped us to create a text that will truly meet the needs of today’s students and instructors. We are sincerely grateful to the following individuals for their participation in the process:

Reviewers for 5e:

Wagdy Abdallah, Seton Hall University

Nas Ahadiat, California State Polytechnic University-Pomona

Wede E. Brownell, University of Central Oklahoma

Jeffrey Cohen, Boston College

Cheryl Corke, Genesee Community College

Joe Dowd, Eastern Washington University

Rafik Elias, California State University-Los Angeles

James M. Emig, Villanova University

Sidney Ewer, Missouri State University

Michael Flores, Wichita State University

Sanjay Gupta, Valdosta State University

Betty Harper, Middle Tennessee State University

Jeannie Harrington, Middle Tennessee State University

Todd Jensen, California State University-Sacramento

Larry N. Killough, Virginia Polytechnic Institute

Leslie Kren, University of Wisconsin–Milwaukee

Joetta Malone, Strayer University

Man C. Maloo, Towson University

Linda Marquis, Northern Kentucky University

John McGowan, St. Louis University

Michael Morris, University of Notre Dame

Ann Murphy, Metropolitan State College of Denver

Lisa Owens, Clemson University

Martha L. Sale, Sam Houston State University

Marsha Scheidt, University of Tennessee–Chattanooga

Kenneth P. Sinclair, Lehigh University

Shiv Sharma, Robert Morris University

Rich White, Florida Metro University

Previous Edition Reviewers: Vidya N. Awasthi, Seattle University

K. R. Balachandran, New York University

Mohamed E. Bayou, School of Management, University of Michigan–Dearborn

Marvin L. Bouillon, Iowa State University

Wayne Bremser, Villanova University

Bea Chiang, The College of New Jersey

Dennis Caplan, Oregon State University

Alan B. Czyzewski, Indiana State University

Robert J. DePasquale, Saint Vincent College

Robert W. Duron, Chadron State College

David Eichelberger, Austin Peay State University

Jerry W. Ferry, University of North Alabama

Michael Flores, Wichita State University

Jay D. Forsyth, Central Washington University

Mike Grayson, Jackson State University

Olen L. Greer, Southwest Missouri State University

Donald C. Gribbin, Southern Illinois University

Judith A. Harris, Nova Southeastern University

Aleecia Hibbets, University of Louisiana–Monroe

Jay Holmen, University of Wisconsin–Eau Claire

Linda Holmes, University of Wisconsin–Whitewater

Norma C. Holter, Towson University

David R. Honodel, University of Denver

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xvi Acknowledgments

Bambi Hora, University of Central Oklahoma

Paul Juras, Wake Forest University

Sanford R. Kahn, University of Cincinnati

Larry N. Killough, Virginia Polytechnic Institute and State University

Mehmet C. Kocakulah, University of Southern Indiana

Laura Jean Kreissl, University of Wisconsin–Parkside

Sandra S. Lang, McKendree College

Randall E. LaSalle, West Chester University of Pennsylvania

Dan Law, Gonzaga University

Stephen Makar, University of Wisconsin–Oshkosh

Brian L. McGuire, University of Southern Indiana

Laurie B. McWhorter, Mississippi State University

Yaw M. Mensah, Rutgers University

Cheryl E. Mitchem, Virginia State University

Jennifer Niece, Assumption College

Margaret O’Reilly-Allen, Rider University

Chei M. Paik, George Washington University

Hugh Pforsich, University of Idaho

Shirley Polejewski, University of St. Thomas

Jenice Prather-Kinsey, University of Missouri–Columbia

Dennis Shanholtzer, Metropolitan Slate University

Kenneth P. Sinclair, Lehigh University

John L. Stancil, Florida Southern College

Ronald A. Stunda, Birmingham–Southern College

Jerry Thorne, North Carolina A&T State University

We also want to recognize the special efforts of:

Michael Garner

Scott Stier

Jaime Kudary

Finally, we are most appreciative of the outstanding assistance and support provided by the professionals of McGraw-Hill/Irwin: Stewart Mattson, our editorial director, and Dick Hercher, Executive Editor, for their guidance; our developmental editor, Rebecca Mann, for her invaluable suggestions; Sankha Basu, our marketing manager, for his significant promo-tional efforts; Bruce Gin, our project manager, for his attention to detail; Matt Diamond, for the outstanding presentation of the text; and Gregory Bates, our media project manager, for his technical expertise in delivering our multimedia material. An added thanks to Beth Woods and Ilene Leopold Persoff for their significant contributions to the accuracy of our text.

Ed Blocher

David E. Stout

Gary Cokins

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xvii

Brief Contents

PART ONE Introduction to Strategy, Cost Management, and Cost Systems 1

1 Cost Management and Strategy 2

2 Implementing Strategy: The Value Chain, the Balanced Scorecard, and the Strategy Map 33

3 Basic Cost Management Concepts 63

4 Job Costing 91

5 Activity-Based Costing and Customer Profitability Analysis 127

6 Process Costing 180

7 Cost Allocation: Departments, Joint Products, and By-Products 231

PART TWO Planning and Decision Making 273

8 Cost Estimation 274

9 Profit Planning: Cost-Volume-Profit Analysis 325

10 Strategy and the Master Budget 364

11 Decision Making with a Strategic Emphasis 430

12 Strategy and the Analysis of Capital Investments 476

13 Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing 545

PART THREE Operational-Level Control 589

14 Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial Performance Measures 590

15 Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management 645

16 Operational Performance Measurement: Further Analysis of Productivity and Sales 704

17 The Management and Control of Quality 746

PART FOUR Management-Level Control 799

18 Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard 800

19 Strategic Performance Measurement: Investment Centers 845

20 Management Compensation, Business Analysis, and Business Valuation 894

GLOSSARY 931

INDEX 942

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xviii

Contents PART ONE INTRODUCTION TO STRATEGY, COST MANAGEMENT, AND COST SYSTEMS 1

Chapter 1 Cost Management and Strategy 2

Management Accounting and the Role of Cost Management 3

The Four Functions of Management 4 Strategic Management and the Strategic Emphasis in Cost Management 6 Types of Organizations 6

The Contemporary Business Environment 7 The Global Business Environment 8 Lean Manufacturing 8 Use of Information Technology, the Internet, and Enterprise Resource Management 8 Focus on the Customer 9 Management Organization 9 Social, Political, and Cultural Considerations 10

The Strategic Focus of Cost Management 10 Contemporary Management Techniques: The Management Accountant’s Response to the Contemporary Business Environment 10

The Balanced Scorecard (BSC) and Strategy Map 11 The Value Chain 12 Activity-Based Costing and Management 12 Business Intelligence 12 Target Costing 12 Life-Cycle Costing 12 Benchmarking 13 Business Process Improvement 13 Total Quality Management 13 Lean Accounting 13 The Theory of Constraints 13 Enterprise Sustainability 14 Enterprise Risk Management 14

How a Firm Succeeds: The Competitive Strategy 14 Developing a Competitive Strategy 15

Cost Leadership 16 Differentiation 16 Other Strategic Issues 16 The Five Steps for Strategic Decision Making 18

The Professional Environment of Cost Management 19 Professional Organizations 19 Professional Certifications 21 Professional Ethics 21

Summary 23 Key Terms 24 Comments on Cost Management in Action 24

Self-Study Problem 25 Questions 25 Brief Exercises 26 Exercises 26 Problems 26 Solution to Self-Study Problem 32

Chapter 2 Implementing Strategy: The Value Chain, the Balanced Scorecard, and the Strategy Map 33

Strengths-Weaknesses-Opportunities-Threats (SWOT) Analysis 34 Execution 36 Value-Chain Analysis 38

Value-Chain Analysis in Computer Manufacturing 39 The Five Steps for Strategic Decision Making for CIC Manufacturing 40

The Balanced Scorecard and the Strategy Map 42 The Balanced Scorecard 42 The Strategy Map 44 Expanding the Balanced Scorecard and Strategy Map: Sustainability 46

Summary 49 Key Terms 49 Comments on Cost Management in Action 49 Self-Study Problems 50 Questions 50 Brief Exercises 51 Exercises 51 Problems 52 Solutions to Self-Study Problems 61

Chapter 3 Basic Cost Management Concepts 63

Costs, Cost Drivers, Cost Objects, and Cost Assignment 64

Cost Assignment and Cost Allocation: Direct and Indirect Costs 64 Cost Drivers and Cost Behavior 67 Activity-Based Cost Drivers 67 Volume-Based Cost Drivers 68 Structural and Executional Cost Drivers 71

Cost Concepts for Product and Service Costing 73 Product Costs and Period Costs 73 Manufacturing, Merchandising, and Service Costing 74 Attributes of Cost Information 76

Summary 78 Key Terms 78 Comments on Cost Management in Action 78

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Contents xix

Self-Study Problem 79 Questions 79 Brief Exercises 80 Exercises 80 Problems 86 Solution to Self-Study Problem 90

Chapter 4 Job Costing 91

Costing Systems 91 Cost Accumulation: Job or Process Costing? 92 Cost Measurement: Actual, Normal, or Standard Costing 92 Overhead Assignment under Normal Costing: Volume-Based or Activity-Based? 93

The Strategic Role of Costing 93 Job Costing: The Cost Flows 93

Direct and Indirect Materials Costs 94 Direct and Indirect Labor Costs 96 Factory Overhead Costs 97 Actual Costing 97 Normal Costing 98

The Application of Factory Overhead in Normal Costing 98

Cost Drivers for Factory Overhead Application 99 Applying Factory Overhead Costs 99 Departmental Overhead Rates 99 Disposition of Underapplied and Overapplied Overhead 100

Job Costing in Service Industries; Project Costing 101 Operation Costing 103 Summary 105 Appendix: Spoilage, Rework, and Scrap in Job Costing 106 Key Terms 107 Comments on Cost Management in Action 108 Self-Study Problem 108 Questions 109 Brief Exercises 109 Exercises 110 Problems 113 Solution to Self-Study Problem 125

Chapter 5 Activity-Based Costing and Customer Profitability Analysis 127

The Strategic Role of Activity-Based Costing 127 Role of Volume-Based Costing 128 Activity-Based Costing 129

Resources, Activities, Resource Consumption Cost Drivers, and Activity Consumption Cost Drivers 129 What Is Activity-Based Costing? 129 The Two-Stage Cost Assignment Procedure 130

Steps in Developing an Activity-Based Costing System 131

Step 1: Identify Resource Costs and Activities 131 Step 2: Assign Resource Costs to Activities 132 Step 3: Assign Activity Costs to Cost Objects 132

Benefits of Activity-Based Costing 133

A Comparison of Volume-Based and Activity-Based Costing 133

Volume-Based Costing 134 Activity-Based Costing 135 The Five Steps of Strategic Decision Making for Haymarket BioTech Inc. 137

Calculating the Cost of Capacity in ABC 138 Activity-Based Management 138

What Is Activity-Based Management? 138 Activity Analysis 139 Value-Added Analysis 139

Real-World Activity-Based Costing/Management Applications 141

ABC/M Application in Manufacturing: Industrial Air Conditioner Units 141 ABC/M Application in the Service Industry: A Retirement and Assisted-Living Community 143 ABC/M Applications in Government 144

Customer Profitability Analysis 146 Customer Cost Analysis 147 Customer Profitability Analysis 148 Customer Lifetime Value and Customer Equity 149

Implementation Issues and Extensions 151 Multistage Activity-Based Costing 152 Resource Consumption Accounting (RCA) 152 Time-Driven Activity-Based Costing (TDABC) 153

Summary 154 Key Terms 154 Comments on Cost Management in Action 155 Self-Study Problem 155 Questions 156 Brief Exercises 156 Exercises 157 Problems 165 Solution to Self-Study Problem 178

Chapter 6 Process Costing 180

Characteristics of Process Costing Systems 181 Equivalent Units 181 Flow of Costs in Process Costing 182 Steps in Process Costing 183 Process Costing Methods 184

Illustration of Process Costing 184 Weighted-Average Method 184 First-In, First-Out (FIFO) Method 189

Comparison of Weighted-Average and FIFO Methods 195 Process Costing with Multiple Departments 195

Transferred-In Costs 195 Weighted-Average Method 196 The FIFO Method 198

Journal Entries for Process Costing 201 Implementation and Enhancement of Process Costing 201

Activity-Based Costing and the Theory of Constraints 201 Just-in-Time Systems and Backflush Costing 202

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xx Contents

Summary 203 Appendix: Spoilage in Process Costing 204 Key Terms 207 Comments on Cost Management in Action 207 Self-Study Problems 208 Questions 209 Brief Exercises 209 Exercises 210 Problems 214 Solutions to Self-Study Problems 225

Chapter 7 Cost Allocation: Departments, Joint Products, and By-Products 231

The Strategic Role of Cost Allocation 232 The Ethical Issues of Cost Allocation 233 Cost Allocation to Service and Production Departments 233

First Phase: Trace Direct Costs and Allocate Indirect Costs to Departments 235 Allocation Phases Two and Three 236 Implementation Issues 240

Cost Allocation in Service Industries 246 Joint Product Costing 248

Methods for Allocating Joint Costs to Joint Products 249 Summary 253 Appendix: By-Product Costing 253 Key Terms 256 Comments on Cost Management in Action 256 Self-Study Problem 256 Questions 256 Brief Exercises 257 Exercises 258 Problems 260 Solution to Self-Study Problem 271

PART TWO PLANNING AND DECISION MAKING 273

Chapter 8 Cost Estimation 274

Strategic Role of Cost Estimation 274 Using Cost Estimation to Predict Future Costs 275 Using Cost Estimation to Identify Cost Drivers 275

Six Steps of Cost Estimation 276 Step 1: Define the Cost Object to Be Estimated 276 Step 2: Determine the Cost Drivers 276 Step 3: Collect Consistent and Accurate Data 276 Step 4: Graph the Data 277 Step 5: Select and Employ the Estimation Method 277 Step 6: Assess the Accuracy of the Cost Estimation 277

Cost Estimation Methods 277 An Illustration of Cost Estimation 277 High-Low Method 277 Regression Analysis 280 Using Spreadsheet Software for Regression Analysis 286

Illustration of the Use of Regression Analysis in the Gaming Industry 287

The Five Steps of Strategic Decision Making for Harrah’s 287

Implementation Problems: Nonlinearity 288 Summary 289 Appendix A: Learning Curve Analysis 290 Appendix B: Regression Analysis 293 Key Terms 299 Comments on Cost Management in Action 299 Self-Study Problems 300 Questions 303 Brief Exercises 303 Exercises 304 Problems 309 Solutions to Self-Study Problems 321

Chapter 9 Profit Planning: Cost-Volume-Profit Analysis 325

Cost-Volume-Profit Analysis 325 Contribution Margin and Contribution Income Statement 326

Strategic Role of CVP Analysis 327 CVP Analysis for Breakeven Planning 328

Equation Method: For Breakeven in Units 329 Equation Method: For Breakeven in Dollars 330 Contribution Margin Method 331

CVP Analysis for Profit Planning 332 Revenue Planning 332 Cost Planning 333 Including Income Taxes in CVP Analysis 336

CVP Analysis for Activity-Based Costing 336 Sensitivity Analysis of CVP Results 338

What-If Analysis of Sales: Contribution Margin and Contribution Margin Ratio 338 Margin of Safety 339 Operating Leverage 339 The Five Steps of Strategic Decision Making for CVP Analysis 341

CVP Analysis with Two or More Products 342 Value Stream Accounting and CVP 343

CVP Analysis for Not-for-Profit Organizations 344 Assumptions and Limitations of CVP Analysis 344

Linearity, the Relevant Range, and Step Costs 344 Identifying Fixed and Variable Costs for CVP Analysis 345


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Contents xxi

Chapter 10 Strategy and the Master Budget 364

Role of Budgets 365 Strategy, the Long-Term Plan, and the Master Budget 366

Importance of Strategy in Budgeting 366 Formulation of Strategy 366 Strategic Goals and Long-Term Objectives 367 Short-Term Objectives and the Master Budget 367

The Budgeting Process 369 Budget Committee 369 Budget Period 369 Budget Guidelines 370 Initial Budget Proposal 370 Negotiation, Review, and Approval 371 Revision 371 Comprehensive Budgeting Example: Kerry Window Systems, Inc. (KWS) 372 The Five Steps of Strategic Decision-Making for Kerry Window Systems, Inc 372

Master Budget 373 Sales Budget 373 Manufacturing Budgets 374 Merchandise Purchases Budget 380 Selling and General Administrative Expense Budget 380 Cash Receipts (Collections) Budget 381 Cash Budget 382 Budgeted Income Statement 384 Budgeted Balance Sheet 384

Uncertainty and the Budgeting Process 386 What-If Analysis 386 Sensitivity Analysis 387 Integrated Budgeting and Planning Software 388

Budgeting in Service Companies 389 Budgeting in Service Industries 389

Alternative Budgeting Approaches 390 Zero-Base Budgeting (ZBB) 391 Activity-Based Budgeting (ABB) 391 Time-Driven Activity-Based Budgeting 393 Kaizen (Continuous Improvement) Budgeting 394

Behavioral Issues in Budgeting 395 Budgetary Slack 395 Goal Congruence 395 Authoritative or Participative Budgeting? 395 Difficulty Level of the Budget Target 396 Linkage of Compensation and Budgeted Performance 396


Chapter 11 Decision Making with a Strategic Emphasis 430

The Five Steps of the Decision-Making Process 430 Relevant Cost Analysis 431

Relevant Cost Information 431 Batch-Level Cost Drivers 433 Fixed Costs and Depreciation 434 Other Relevant Information: Opportunity Costs 434

Strategic Cost Analysis 434 Special Order Decisions 435 Relevant Cost Analysis 435 Strategic Analysis 437

Is TTS Now Operating at Full Capacity? 437 Excessive Relevant Cost Pricing 437 Other Important Strategic Factors 438

Value Stream Accounting and the Special Order Decision 438 Make, Lease, or Buy Decision 438 Relevant Cost Analysis 438 Strategic Analysis 441 Sell Before or After Additional Processing 441 Relevant Cost Analysis 441 Strategic Analysis 442 Profitability Analysis 442 Profitability Analysis: Keep or Drop a Product Line 442

Strategic Analysis 444 Profitability Analysis: Service and Not-for-Profit Organizations 444 Multiple Products and Limited Resources 445 Case 1: One Production Constraint 445 Case 2: Two or More Production Constraints 447 Behavioral and Implementation Issues 448 Consideration of Strategic Objectives 448 Predatory Pricing 448 Replacement of Variable Costs with Fixed Costs 449 Proper Identification of Relevant Factors 450 Summary 450 Appendix: Linear Programming and the Product Mix Decision 451 Key Terms 453 Comments on Cost Management in Action 453 Self-Study Problems 453 Questions 454 Brief Exercises 455 Exercises 456 Problems 460 Solutions to Self-Study Problems 474

Chapter 12 Strategy and the Analysis of Capital Investments 476

Strategy and the Analysis of Capital Expenditures 477 Underlying Nature of Capital Investments 477 Organizational Strategy and Capital-Investment Analysis 477

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xxii Contents

Effect of Capital Expenditures on Strategic Cost Drivers 478 Chapter Overview—Where Are We Headed? 479

The Role of Accounting in the Capital-Budgeting Process 479

Linkage to the Master Budget 479 Linkage to Strategy and to the Balanced Scorecard (BSC) 479 Generation of Relevant Financial Data for Decision-Making Purposes 481 Conducting Post-Audits 482 The Five Steps of Strategic Decision Making: Cost-Benefit Analysis of a Hospital Bar-Code Technology Investment 482

Identification of Relevant Cash-Flow Data for Capital-Expenditure Analysis 484

Why Focus on Cash Flows? 484 Cash Flows—A Framework for Analysis 484 Sample Data Set: Mendoza Company—Equipment-Replacement Decision 484 Determining After-Tax Cash Flows for Capital-Investment Analysis 485 Recap— After-Tax Cash Flow Information for the Mendoza Company Investment Proposal 491

Discounted Cash Flow (DCF) Capital-Budgeting Decision Models 492

Types of Capital-Budgeting Decision Models 492 DCF Models: Specifying the Discount Rate 492 Estimating the WACC 494 Net Present Value (NPV) Decision Model 496 Internal Rate of Return (IRR) Decision Model 497 The Modified Internal Rate of Return (MIRR) 499 Comparison of NPV and IRR Methods: Which to Use? 500 Templates for Structuring a DCF Capital-Budgeting Analysis 500

Uncertainty and the Capital-Budgeting Process 500 What-If Analyses 500 Scenario Analysis 502 Monte Carlo Simulation 503 Real Options 503

Other Capital-Budgeting Decision Models 507 Payback Period 507 Accounting (Book) Rate of Return 509

Behavioral Issues in Capital Budgeting 510 Common Behavioral Problems: Cost Escalation, Incrementalism, and Uncertainty Intolerance 510 Goal-Congruency Issues 511 Addressing the Goal-Congruency Problem 512

Summary 513 Appendix A: Spreadsheet Templates for Conducting a DCF Analysis 515 Appendix B: DCF Models: Some Advanced Considerations 517 Appendix C: Present Value Tables 520 Key Terms 522 Comments on Cost Management in Action 522 Self-Study Problem 522 Questions 523

Brief Exercises 524 Exercises 525 Problems 530 Solution to Self-Study Problem 541

Chapter 13 Cost Planning for the Product Life Cycle: Target Costing, Theory of Constraints, and Strategic Pricing 545

Target Costing 547 Value Engineering 548 Target Costing and Kaizen 550 An Illustration: Target Costing in Health Product Manufacturing 551 An Illustration Using Quality Function Deployment (QFD) 552 Benefits of Target Costing 553

The Theory of Constraints 554 The Use of the Theory of Constraints Analysis in Health Product Manufacturing 555 Steps in the Theory of Constraints Analysis 555 The Five Steps of Strategic Decision Making for Speed and Efficiency in the Fashion Industry 559 Theory of Constraints Reports 560 Activity-Based Costing and the Theory of Constraints 560

Life-Cycle Costing 561 The Importance of Design 562 The Use of Life-Cycle Costing in a Software Firm 563

Strategic Pricing Using the Product Life Cycle 564 Pricing Using the Cost Life Cycle 564 Strategic Pricing for Phases of the Sales Life Cycle 566 Strategic Pricing: Analytical Pricing Methods 566

Summary 567 Appendix: Using the Flow Diagram to Identify Constraints 567 Key Terms 568 Comments on Cost Management in Action 568 Self-Study Problem 569 Questions 569 Brief Exercises 570 Exercises 570 Problems 576 Solution to Self-Study Problem 587

PART THREE OPERATIONAL-LEVEL CONTROL 589

Chapter 14 Operational Performance Measurement: Sales, Direct-Cost Variances, and the Role of Nonfinancial Performance Measures 590

Management Accounting and Control Systems 591 Developing an Operational Control System: The Five Steps of Strategic Decision Making for Schmidt Machinery 592

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Contents xxiii

Short-Term Financial Control 592 Flexible-Budgets and Profit-Variance Analysis 593

The Flexible Budget 593 Sales Volume Variance and the Total Flexible-Budget Variance 596 Breakdown of the Total Flexible-Budget Variance 597 Selling Price Variance 597 Variable Cost Flexible-Budget Variances 598 Further Analysis of the Total Variable Cost Flexible-Budget Variance 599 General Model for the Analysis of Variable Cost Variances 599 Direct Materials Variances 600 Direct Labor Variances 604 Timing of Variance Recognition 606

Standard Costs 607 Standard Costs versus a Standard Cost System 607 Types of Standards 607 Standard-Setting Procedures 608 Establishing Standard Costs 609 Standard Cost Sheet 610

Recording Cost Flows and Variances in a Standard Cost System 610

Direct Materials Cost 611 Direct Labor Cost 612 Completion of Production 613

The Strategic Role of Nonfinancial Performance Indicators 614

Limitations of Short-Term Financial-Performance Indicators 614 Business Processes 614 Operating Processes 615 Just-in-Time (JIT) Manufacturing 615


Chapter 15 Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management 645

Standard Overhead Costs: Planning versus Control 646 Variance Analysis for Manufacturing Overhead Costs 648

Variable Overhead Cost Analysis 648 Interpretation and Implications of Variable Overhead Variances 649 Fixed Overhead Cost Analysis 650 Interpretation of Fixed Overhead Variances 655 Alternative Analyses of Overhead Variances 656 Summary of Overhead Variances 657

Recording Standard Overhead Costs 657 Journal Entries and Variances for Overhead Costs 657 Variance Disposition 659 The Effects on Absorption Costing Income of Denominator-Level Choice in Allocating Fixed Overhead 661

Standard Costs in Service Organizations 662 Overhead Cost Variances in ABC Systems 664

ABC-Based Flexible Budgets for Control 664 Flexible-Budget Analysis under ABC When There Is a Standard Batch Size for Production Activity 667 Extension of ABC Analysis: GPK and RCA 668 Supplementing Financial Results with Nonfinancial Performance Indicators 668

Investigation of Variances 669 Causes and Controllability 670 Role of Control Chart 671

Summary 671 Appendix: Variance Investigation Decisions under Uncertainty 673 Key Terms 676 Comments on Cost Management in Action 676 Self-Study Problems 676 Questions 678 Brief Exercises 679 Exercises 679 Problems 688 Solutions to Self-Study Problems 700

Chapter 16 Operational Performance Measurement: Further Analysis of Productivity and Sales 704

The Strategic Role of the Flexible Budget in Analyzing Sales and Productivity 705 Analyzing Productivity 706

Partial Productivity 708 Total Productivity 712

Analyzing Sales: Comparison with the Master Budget 713

Sales Volume Variance Partitioned into Sales Quantity and Sales Mix Variances 714 Sales Quantity Variance Partitioned into Market Size and Market Share Variances 718 The Five Steps of Strategic Decision Making for Schmidt Machinery 721

Analyzing Sales: Comparison with Prior Year Results 722

Analysis of Selling Price and Volume Variances 723 Analysis of Mix and Quantity Variances 724 Analysis of Variable Cost Variances 725

Summary 725 Key Terms 726 Comments on Cost Management in Action 726 Self-Study Problems 726 Questions 727 Brief Exercises 728

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xxiv Contents

Exercises 729 Problems 732 Solutions to Self-Study Problems 741

Chapter 17 The Management and Control of Quality 746

The Strategic Importance of Quality 746 Baldrige Quality Award 747 ISO 9000 and ISO 14000 747 Quality and Profitability: Conceptual Linkage 747

Accounting’s Role in the Management and Control of Quality 749

The Five Steps of Strategic Decision Making: Improving Quality in Pharmaceutical and Medical-Product Companies 749 Chapter Preview 750

Comprehensive Framework for Managing and Controlling Quality 750

The Meaning of Quality 750 Knowledge of Business Processes 750 Role of the Customer 752 Financial Component 752 Nonfinancial Performance Indicators 752 Feedback Loops 752 Relevant Cost Analysis 753 Link to Operations Management 753 Breadth of the System 753

Setting Quality-Related Expectations: The Role of Six Sigma 754

Setting Quality Expectations: A Six Sigma Approach 754 Setting Quality Expectations: Goalpost versus Absolute Conformance Standards 756 Goalpost Conformance 756 Absolute Quality Conformance 757 Goalpost or Absolute Conformance? 757

Financial Measures and Cost of Quality (COQ) 758 Relevant Cost Analysis 758 Cost of Quality (COQ) Reporting 759 COQ Reports 761 COQ and Activity-Based Costing (ABC) 764

Nonfinancial Quality Indicators 764 Internal Nonfinancial Quality Metrics 764 External (Customer Satisfaction) Quality Metrics 765 Role of Nonfinancial Performance Measures 766

Detecting and Correcting Poor Quality 766 Detecting Poor Quality 766 Taking Corrective Action 768

Lean Manufacturing and Accounting for Lean 771 Lean Manufacturing 771 Accounting for Lean 772 The Strategic Role of Lean Accounting 773

Summary 775 Appendix: Taguchi Quality Loss Function 776 Key Terms 779 Self-Study Problems 779

Questions 780 Brief Exercises 781 Exercises 782 Problems 789 Solutions to Self-Study Problems 797

PART FOUR MANAGEMENT-LEVEL CONTROL 799

Chapter 18 Strategic Performance Measurement: Cost Centers, Profit Centers, and the Balanced Scorecard 800

Performance Measurement and Control 801 Operational Control versus Management Control 801 Objectives of Management Control 802 Employment Contracts 803

Design of Management Control Systems for Motivation and Evaluation 805

Informal Control Systems 806 Formal Control Systems 806

Strategic Performance Measurement 806 Decentralization 807 Types of Strategic Business Units 807 The Balanced Scorecard 808

Cost Centers 808 Strategic Issues Related to Implementing Cost Centers 808 Implementing Cost Centers in Departments 809 Outsourcing or Consolidating Cost Centers 811 Cost Allocation 812

Revenue Centers 813 Profit Centers 814

Strategic Role of Profit Centers 814 The Contribution Income Statement 815 Variable Costing versus Full Costing 816 The Contribution Income Statement and Value Streams 819

Strategic Performance Measurement and the Balanced Scorecard 819

Implementing the Balanced Scorecard and the Strategy Map for Performance Evaluation 819 Implementing Strategy using the BSC: Six Steps to Maximize the Value of Nonfinancial Measures 820

Management Control in Service Firms and Not-for-Profit Organizations 821 Summary 822 Key Terms 823 Comments on Cost Management in Action 823 Self-Study Problem 823 Questions 824 Brief Exercises 824 Exercises 825 Problems 829 Solution to Self-Study Problem 844

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Contents xxv

Chapter 19 Strategic Performance Measurement: Investment Centers 845

Five Steps in the Evaluation of the Financial Performance of Strategic Investment Units in an Organization 845

Part One: Financial-Performance Indicators for Investment Centers 847 Return on Investment 847

ROI Equals Return on Sales Times Asset Turnover 847 Illustration of Evaluation Using ROI 848 Return on Investment: Measurement Issues 850 Strategic Issues Regarding the Use of ROI 854

Residual Income 856 Time Period of Analysis 857 Limitations of Residual Income 858

Economic Value Added® 859 Estimating EVA® 859 Alternative Approaches to Estimating EVA® NOPAT and EVA® Capital 860

Using Average Total Assets 861 Part Two: Transfer Pricing 861 When Is Transfer Pricing Important? 862 Objectives of Transfer Pricing 862 Transfer-Pricing Methods 863

Choosing the Right Transfer-Pricing Method: The Firmwide Perspective 863

General Transfer-Pricing Rule 866 International Issues in Transfer Pricing 867

Other International Considerations 868 Advance Pricing Agreements 869


Chapter 20 Management Compensation, Business Analysis, and Business Valuation 894

Part One: Management Compensation 894 Types of Management Compensation 895 Strategic Role and Objectives of Management Compensation 896

Design the Compensation Plan for Existing Strategic Conditions 896 Risk Aversion and Management Compensation 896 Ethical Issues 897 Objectives of Management Compensation 897

Bonus Plans 898 Bases for Bonus Compensation 898 Bonus Compensation Pools 900 Bonus Payment Options 901

Tax Planning and Financial Reporting 903 Management Compensation in Service Firms 903 Part Two: Business Analysis and Business Valuation 905 Business Analysis 905

The Balanced Scorecard 906 Financial Ratio Analysis 907

Business Valuation 908 The Discounted Cash Flow Method 909 Multiples-Based Valuation 911 Enterprise Value 911 An Illustration of the Five Steps of Strategic Decision Making in the Valuation of a Fashion Retailer 911


Glossary 931

Index 942

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The objective of the first seven chapters is to introduce the strategic approach to cost manage-ment and to cover the basic concepts of cost accounting systems.

Chapter 1 is an introduction to cost management—how companies plan for success and the management accountant’s role in implementing strategy. The chapter includes coverage of the Institute of Management Accountants newly revised definition of management accounting. It is also an introduction to the current environment of business including contemporary man-agement techniques and professional responsibilities.

Chapter 2 focuses on some of the principal means that organizations use to implement strat-egy. The chapter introduces a strategic management system known as the balanced scorecard (BSC), the strategy map, and the value chain, and shows how these tools can be used to help the organization implement its strategy. These tools are foundational tools that appear through-out the text; this is why they are covered in this early chapter.

Chapter 3 defines the key terms that management accountants use to describe product cost systems and cost information for planning, decision making, and control. This terminology is important for both accountants and managers alike. The chapter also introduces the differences in management accounting between service, manufacturing, and merchandising companies.

Chapters 4–7 cover costing systems and their role in strategy implementation. Chapter 4 provides an introduction to costing systems by defining the elements of cost and how these elements are combined to determine the cost of a cost object (e.g., product or service). The chapter assumes a volume-based approach for allocating indirect costs to cost objects. There are a number of variations on this basic cost system, each of which is designed to fit a particular manufacturing or service environment. These variations are explained in Chapters 5, 6, and 7. Standard costing is considered primarily a control tool and is included in Part Three, Operational-Level Control.

Chapter 5 covers a strategically important advance in product costing called activity-based costing (ABC). Rather than using the volume-based approach (explained in Chapter 4), the ABC approach incorporates the details of all the activities that are needed to provide the prod-uct or service. The result is much more accurate, and therefore more strategically useful, cost information regarding the resource demands of an organization’s outputs.

Chapter 6 introduces process costing, a costing system that is applicable for firms that have relatively homogeneous products passing through similar processing steps, often in a con-tinuous flow. Commodity-based industries are of this nature: food processing, chemical, and consumer products firms.

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